As a business owner, you’ve likely worked much of your life to build your company. While this growth will have increased your equity, it has also created a liability from a tax perspective. But there are strategies to preserve your net worth.
When a business owner dies, taxes may have to be paid on capital gains and they can mount up. But there are payment options to consider.
One strategy involves planning to use life insurance benefits to pay for the tax on future capital gains. The cost of the insurance premiums is typically much less than the anticipated tax bill would be, and the equity in the business is preserved for the heirs.
Here’s a bit more information to help you with your planning.
Background on capital gains
If you sell (or are considered to have sold) all or part of your company for more than the adjusted cost base plus outlays and expenses associated with the sale, you incur a capital gain. In Canada, tax is paid on 50% of the gain.
The amount of tax owed if a business owner dies can be substantial. For example, a capital gain of $4 million means that capital gains tax will be paid on $2 million at the owner’s marginal tax rate (MTR) at the time of death.
Life insurance can protect net worth
As a business owner, your future capital gains tax bill can be estimated based on a professional business valuation. Life insurance benefits can then be calculated to cover the tax in the event you pass away, and the premiums over your expected lifetime can also be determined.
Because the insurance premiums over your expected lifetime are often far less than the anticipated capital gains tax, purchasing insurance can potentially save your estate a substantial amount of money.
The company can pay the life insurance premiums for owners of incorporated businesses and the company will receive the insurance benefits tax-free.
No need to sell the business or other assets
Using insurance benefits to pay the tax protects your heirs from having to sell the business or other property to come up with the necessary funds. Being forced to liquidate assets to pay the tax bill is not a good situation to be in. Market conditions may be poor and finding a buyer may take a long time. The value attained for the assets can be significantly less than expected.
For heirs, dealing with the loss of a loved one is hard enough without having to make these types of highly stressful decisions at the same time.
Insurance strategies vary
The strategy for using life insurance benefits to pay for future capital gains tax will vary depending on the particular situation. And while the basic premise is consistent, there are also investment options to consider that may make sense to offset the cost of the premiums.
As a business owner, you may choose to keep assets – including real estate holdings – under corporate ownership. But this often creates a future capital gains tax liability.
Life insurance will cover these taxes in the event of unexpected death. You can also build an investment component into the insurance strategy. Over time, the value accrued through the investments can equal the insurance premiums paid. If the policy is terminated before needed (before the owner dies), the cost of the insurance can potentially be covered by the increase in the value of the investments.
Create a strategy that works for you
Making decisions regarding insurance strategies for covering future capital gains tax liabilities can be very complicated. Every situation is different and your company’s liquidity needs to be considered.
While your accountant can develop a structure for you, advice is typically required when it comes to implementation. A team approach where a business advisor and an insurance advisor partner and work with you to create a solution is the ideal approach.
A well-developed strategy can protect hard-earned net worth from tax. It is worth the time to explore your options.
Patryk Swierkowski
Business Advisor
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The information contained in this article/video was written by BlueShore Financial or one of our expert financial writers and was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete. It is provided as a general source of information and should not be considered personal financial advice.